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From niche to norm

ESG integration into stewardship responsibilities by institutional investors in Japan

Background

The introduction of the Japanese Stewardship Code has acted as a catalyst in promoting responsible ownership of investee companies by Japanese institutional investors. The Code was introduced in 2014 by the Financial Services Authority in order to “promote sustainable growth of companies through investment and dialogue”. The Code represented an important step in recognizing the link between investors’ stewardship practices, including the consideration of environmental, social, and governance (ESG) information, and long term value creation.

Over 200 institutional investor signatories proceeded to adopt the Code as of the end of 2016. This also coincided with a steady growth of signatories to the Principles for Responsible Investment (PRI). In the same timeframe, a survey of institutional investors by JSIF identified a total of 56.25 trillion JPY assets under management using sustainable investment strategies as of October 2016, more than doubling the sustainable investment assets that were identified for the previous year. These trends have further validated the notion that ESG and Stewardship have an important role to play in the effective management of, and interaction within, capital markets in Japan.

FTSE Blossom Japan Index

Recognizing this shift, FTSE Russell has designed the FTSE Blossom Japan Index to help investors and other market participants integrate and promote ESG considerations. The name “Blossom” refers to the cherry blossom tree which is one of Japan’s most recognized national symbols, and also because of the blooming nature of stewardship and the integration of ESG in Japan.

The FTSE Blossom Japan Index can be used to assist in the integration of ESG considerations into a diversified investment strategy. The index, as this paper will describe, can be used to enhance ESG exposure while maintaining the index characteristics of a broad market benchmark, and also provides a strong basis for corporate engagement.

Informing stewardship and engagement strategies

The alignment of stewardship efforts, particularly corporate engagement strategies, with investment activities creates consistent and strong incentives for change. The transparent ESG methodology of the FTSE Blossom Japan Index, based on FTSE Russell’s ESG Ratings, provides a strong basis for engagement with listed companies. The annual assessment and ESG Ratings provides a measurement for engagement success that can be tested over time. Academic analysis by Edinburgh and Nottingham Universities has found that corporate engagement linked to the FTSE4Good Index Series’ ESG inclusion criteria has had a significant effect on corporate practices.

FTSE Blossom methodology summaryESG methodology

The FTSE Blossom Japan Index incorporates over 15 years of ESG expertise by incorporating the well-established and transparent inclusion criteria used by the FTSE4Good Index Series, in particular a positive selection method based on FTSE Russell’s ESG Ratings that measures a company’s exposure to, and management of, ESG issues in multiple dimensions.

The criteria used to assign an ESG rating to a company are based on publicly available data and this model has been designed with the oversight of the independent FTSE Russell ESG Advisory Committee. The committee is comprised of experts from the investment community, NGOs, unions, and academia. A company’s ESG rating is reviewed annually. To calculate an ESG rating, each company is evaluated across 14 different Themes using a model with over 300 specific indicators. On average each company is assessed against 125 of these indicators. The following graphic summarizes the ESG Ratings and data model.

Upon evaluation of the relevant indicators, each company receives both a measure for Exposure and a Score for each of the Themes. The Exposure (0 to 3, where 3 is the highest) is a measure of the relevance of each ESG Theme to the company, whereas the Score (0 to 5, where 5 is the highest) reflects the quality of the company’s management of the issues related to each ESG Theme. The Exposure is determined by factors such as business activities and geographical footprint that impact how relevant certain ESG issues are, a chemical company would have a higher Exposure for the “Pollution and Resource” Theme than a software company and would therefore be assessed on more indicators for that Theme. The company would also be “graded” on a tougher curve, which means a higher percentage of indicators are required to get an equivalent Score for that particular Theme. In this way, the ESG Ratings reflect a company-specific measure of ESG performance based on the relevance of the 14 Themes in the data model.

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